By David Adams
I am having an ongoing discussion with one of my traders who is struggling with proper exit strategies on both winning and losing trades. It has been a frustrating battle, but has been beneficial for my own education. The market offers, at times, some handsome profits and can deal out devastating losses. The question becomes when to exit a bad trade and when to take profits on a good trade.
A good number of trading education books suggest that letting your profits run is a great idea. I can’t say I disagree with this notion, but in practice it is less than easy to implement. Say you are trading an ES contract with a three-point target (12 ticks) and the market begins to stall or reverse at 10 ticks. What do you? Do you let your profits retrace past your breakeven point? Do you immediately take the money and run?
As a scalper, this is a very difficult question to answer. I know what my answer would be. I would take my profit at 10 ticks and look for another profitable trade. One of the axioms I try to implement in all my trading is: Never let a winning trade become a losing trade. Of course, you might move your stop loss up to plus five and settle for small gain, and that is not necessarily a bad strategy. But for me, I would take the 10 ticks. Good trades come and go throughout the course of the day and my job is to find another quality trade, not wring every last tick out of my current trade. Then again, I don’t feel great about myself when the market careens in my direction another three points; this is money I could’ve had. When I was at 10 ticks though, I didn’t know that the market was going to continue in my direction. What I did know was that I had banked a solid gain, and in my mind that’s good enough.
Stop losses, on the other hand, are even more difficult to handle. When executing the trade most traders believe that it will be profitable. Unfortunately, some trades do not move in the proper direction and the trader must decide how much he is willing to lose, or risk. I have had many trades go with than one or two ticks of my stop loss and come back to be solid gainers. On the other hand, just as many have exploded through my stop loss target with little regret. Here is the point, it is not necessary to hit your stop loss to exit a trade. When a trade starts to go horribly wrong, why not just exit and look for a better trade?
It sounds very easy to exit a trade; unless you initiated the trade expecting it to be profitable, which is where the problem is rooted. It can be difficult, and for some even humiliating, to exit a trade early because the market has changed. I don’t have a hard and fast rule on when to exit a trade. In my mind, when I enter a trade I have an expectation of what is going to happen. If that event does not occur within two or three bars, I am generally looking for a way out of the trade. The longer you stay in a trade that has not met your initial expectation the more likely your chances of winning or losing becomes a matter of luck. Why? Well, after your initial expectation failed the market is developing new internals that may or may not be beneficial to your trade. If you’re lucky, the market moves your way, and vice versa. It’s not a good way to trade.
Oddly enough, I have watched many traders get far out of the money only to have the price retrace back to within one or two ticks of their breakeven price. Instead of flattening with a $25 loss, I have seen, time and time again, a trader let the price reverse direction and they hit their stop loss. What in the world? At an intellectual level it makes sense to accept a small loss and move on to another trade. At the emotional level, I believe some traders want to at least break even. This is a confusing situation, yet I see it very often. The problem lies in the trader’s emotions and his or her unwillingness to accept even a small loss. It’s a common problem; traders become emotionally invested in their trade and make illogical decisions.
In summary, we have discussed exiting trades on both the profit and loss sides of the trading equation. This is an area where emotions play a huge role. I have stated I prefer to take my profits and run, while I have noted many traders tend to hang on to their trade till the bitter end. It all boils down to emotions and emotional attachment to your trade. Your trade may not do what you expect it to do, but you can make the best of what the market offers by thinking clearly.
About the Author
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